Editor's note: Following too many ideas could end up hurting your portfolio...
Being well-rounded is good as a general principle, but in the investing world, stretching yourself in too many directions can introduce a lot of risk. According to Extreme Value editor Dan Ferris, the key to reducing your risk is to know "one big thing" instead of "many smaller things."
In today's Masters Series, last published in the January 2 issue of the free DailyWealth e-letter, Dan explains why knowing if you're a "hedgehog" or "fox" makes the difference between avoiding or taking major losses...
Investing Lessons From 'The Hedgehog and the Fox'
By Dan Ferris, editor, Extreme Value
I keep coming back to a timeless piece of advice...
You must learn to "know yourself well" in order to become a better investor.
Whether you've already discovered a system that works for you or are struggling to improve, investing requires great self-knowledge.
As you can tell, I like simple insights that can help you quickly learn a lot about yourself.
There's another one I've found that I like: Are you a hedgehog or a fox?
And I'm confident this simple question will have profound implications on your personality and your investing performance...
This question comes from a 1953 essay by philosopher Sir Isaiah Berlin. He opens with a line from Greek poet Archilochus: "The fox knows many things, but the hedgehog knows one big thing."
The idea of determining if you're guided by "one big thing" versus "many things" is a valuable way to gauge your own investing style.
Before you answer that question, know that most successful investors are hedgehogs...
Hedgehog investors come up with their own system – their "one big thing" – and they eliminate everything that doesn't conform to it.
Classic hedgehog investor Chris Mayer of Woodlock House Family Capital has his own original investment framework. He calls it the "CODE" system...
- C is for "cheap." He's looking for stocks that are undervalued.
- O is for "owner operator." He wants companies run by folks who own large chunks of their own stock.
- D is for "disclosure." He relies heavily on public disclosures as an outside, passive, minority investor... So they must be good.
- E is for "excellent financial condition." He doesn't like companies with too much debt or other risks on their balance sheets.
Most stocks don't conform to Mayer's framework, so he doesn't often find new investing opportunities. But more important, he also doesn't waste valuable time examining thousands of companies he would never invest in, no matter how popular or profitable they might be.
Berkshire Hathaway (BRK-B) founder Warren Buffett is a classic hedgehog, too. And he only wants to own businesses – publicly traded or not – that have these four characteristics. In order to get his attention, the business must be one that...
- He can understand
- Holds a durable competitive advantage
- Has a management team he can trust
- Is available at a price that's not too expensive
Like Mayer's CODE system, Buffett's four filters constitute "one big thing." And he has built a huge cash-gushing company by focusing like a hedgehog.
But foxes do exist...
Take Jim Rogers, co-founder of the Quantum Fund in 1973. He and George Soros made 3,365% from 1970 through 1980, while the S&P 500 Index rose just 47%.
Rogers doesn't stick to "one big thing"... He'll buy any currency, stock, bond, or other financial instrument from any country. And he'll buy any commodity, any futures contract, or anything else... anywhere, anytime... as long as he believes it's a good bet.
In daily life, most folks seem more foxlike to me. But a hedgehog with zero foxlike characteristics is rare, too...
So maybe answering this question is more complex. Maybe it's just about understanding how each mode of thinking can help you achieve great success at investing (or anything else worth doing).
Maybe we're all destined to be foxes until we learn how to be hedgehogs...
Although Buffett focused on investing from his youth, he dabbled in other areas before concentrating on companies that fit his four core filters...
While running his hedge-fund partnerships in the 1950s and 1960s, Buffett bought many types of classic value plays. At that point, Buffett was ready for anything... He was an investment fox.
Now, I want you to ask yourself this...
In your life so far, have you been a full-blown hedgehog, filtering out everything that didn't coincide with your one big thing?
Or have you been more of a fox, trying different jobs, investments, and other pursuits... ready for anything that felt like the right thing to read, think, or do next?
I'm willing to bet most of you are more foxlike.
So when it comes down to it, the hedgehog-or-fox question is really about self-discovery...
It's not about making up rules that all investors must follow. Every situation is unique. You need to make your own rules or find the ones that work best for you.
However, there is one way in which all investors must become hedgehogs...
A hedgehog's top priority is to avoid being eaten by a fox. Because of that, he evolved to have an ironclad defense against them – his sharp quills. That's a hedgehog's "one big thing."
For investors, not getting killed by a fox means avoiding catastrophic loss. All successful investors are hedgehogs when it comes to risk... It's absolutely impossible to succeed as an investor without learning to recognize, understand, and control risk.
So, the first question you must answer is... are you a hedgehog or a fox?
You're probably more foxlike. You've probably done many things rather than focus on "one big thing" since childhood. It's OK to recognize aspects of both hedgehogs and foxes in your style of living and investing.
Next, you must confront the one non-negotiable fact: All investors must be hedgehogs about risk. Investing hedgehogs know "one big thing"... risk.
After you self-reflect and learn to become a risk-focused hedgehog, I recommend reading broadly on many topics...
Don't be afraid to start a bunch of books and not finish them. Check multiple news sources each day. Get your boots on the ground in places where few others have been. Do your own thinking and ignore advice that confuses you, no matter how much you might admire the person giving it.
I highly recommend studying lots of businesses and becoming familiar with many different assets, one at a time – even if you think you'll never invest in them.
The more different businesses you learn about, the more you'll integrate that knowledge into the "one big thing" of growing wealth by investing your capital.
In the end, most successful investors end up as hedgehogs. But almost everyone winds up living and learning like foxes until they get to that point.
So if you look in the mirror and see a fox today, keep reading and learning. One of these days, you'll catch your reflection and see a hedgehog staring back at you.
Good investing,
Dan Ferris
Editor's note: Dan says America is about to face a reset to its financial system. The White House is preparing to make an announcement as soon as July 4. And it could impact your savings, your portfolio, and your financial future.
However, this reset has the chance to make you 10 times your money... if you know where to look. That's why Dan is urging folks not to be caught unawares when the potentially "biggest trade of all time" launches. Learn how you can prepare yourself here.
